The iPhone 3G S: “S” stands for software

The iPhone 3G S is on the mission to keep the buzz alive but it is apps that will keep consumers glued to the platform.

I bet Apple’s incremental iPhone 3G S upgrade underwhelmed you a bit.

While a better camera, magnetic compass, video recording, voice control, faster CPU/GPU and double the storage are all nice, it’s the iPhone OS 3.0 and SDK 2.0, not the hardware, that will keep Apple ahead of rivals, hopefully creating new revenue streams for developers.

Take In-App Purchase, a new feature of the iPhone OS 3.0 that lets you purchase new content directly in apps, things like e-books, additional levels or items in games, etc.

For example, Gameloft’s racing game Asphalt 5 will let you buy extra cars and new tracks from within the game. Since such sales are processed by the App Store infrastructure, the 70:30 revenue sharing still applies. Will users take the bait?

Two new revenue streams: In-App Purchase and Bluetooth sharing

Joel Evans, our chief geek, thinks this is a “huge revenue stream,” citing Pocket God as the prime example. The game owes its long-standing top 10 ranking to an ever-expanding content brought via free upgrades. With In-App Purchase, such updates could be turned into paid extras. “Enter OS 3.0 and the developer could offer up unique characters, a different story-line, you name it, all for additional money,” Evans said.

One big drawback is the inability to upgrade from free to paid version from within an app. Evans suspects Apple didn’t allow this because it “likes seeing twice as many apps in the App Store by listing free and paid versions separately.” Evans also noted that developers have “no clear way of promoting apps inside of the App Store,” relying instead on traditional advertising to generate a buzz around submitted apps.

Peer-to-peer networking, also part of the iPhone OS 3.0, is another Trojan horse. The feature connects apps via Bluetooth in order to enable over-the-air sharing of items like contacts, photos, locations, documents, etc. “If I like an app and send it to you and you buy it, I have just added a sale I might otherwise have made,” Jack E. Gold, founder and principal analyst at J. Gold Associates, told me in an email interview.

New games will extensively leverage peer-to-peer networking. You might be battling friends in a FPS deathmatch or race your dad in a car game but everyone will need to have a copy of the software in question. Such “viral leverage” will help drive sales of popular apps, especially among friends and family members.

App Store: The third leg of Apple’s software universe

There’s no question that the App Store is one of Apple’s most valuable assets but it is great marketing that set apart Apple’s store from rival offerings.

“What I find most fascinating is that other platforms have been offering an ‘App Store’ of sorts for years. However, it wasn’t until Apple created an effortless way for people to discover, download and install apps to their iPhones that the App Store became the standard to beat”, Evans said. A solid, graphically pleasing experience is also important but rivals are still caught “playing catch-up instead of innovating,” he said.

Indeed, the App Store is now a third leg of Apple’s software universe, in addition to the OS X base code that powers Apple devices and the iTunes Store that feeds paid and free entertainment content. Many analysts hope the App Store would help push future Apple gadgets.

App Store to fuel future gizmos

While somewhat skeptical about this, Evans said he is “ready to be proven wrong,” hinting he is still waiting for Apple to “do something more with the Apple TV.”

Gold, however, has no doubt that the store can double as “an accelerator” for large format devices.

“Users want lots of application options, they find that very attractive when buying a new device,” the analyst said. “App Store does that, and generates revenues for Apple as a bonus.”

When you think of it, the 40,000 apps is a powerful enough rocket fuel to catapult Apple’s next big thing into the stratosphere, just like the iTunes Store and Apple’s credibility in the music space initially boosted the iPhone.

Developers certainly love apps that play on many devices. “That is the lure of Android- and Java-based systems like Blackberry,” Gold said, noting that programmers go “where the numbers are.” Meanwhile, rivals like Microsoft, Palm and Google all struggle to catch up with the App Store in sheer software offering.

While rival stores may provide a solid enough offering for users who don’t want an iPhone, that won’t be enough to satisfy people who want apps that rock. “Microsoft is behind in attracting the cool apps and is even starting to slip with business apps,” Gold said. “With the Pre, it all depends on how many devices Palm can sell,” he warned.

Conclusion: Apple fights for developer resources

Developers operate on constrained resources so they target platforms prudently. Apple understands this. The company’s goal is to make developers successful so they support the platform. Evans expects the App Store to “continue to lead as Apple keeps enhancing the platform and the SDK.”

Huge apps offering paired with over 40 million installed devices (combined iPhone and iPod touch sales to date) are two key incentives to lure talent.

When you think of it, even some consoles lack such a huge installed base.

“The iPhone platform clearly has momentum and developers are taking that very seriously,” Gold said. If you’re planning early retirement, you may also consider selling your iPhone startup.

“This is a race to capture developer resources, and Apple is way ahead,” she said. “It’s all about gaining share, and then the hardware sales will follow.” Application stores are designed to up hardware by locking consumers to the platform. For instance, users who invest in apps are less likely to switch platforms because they can’t take purchased apps with them.

Some also criticize Apple over forbidding you to legally sell purchased apps to other people when you no longer use them. Whichever way you look at it, Apple’s success in the battle for developer resources comes at the expense of other vendors who find it increasingly difficult to talk programmers away from the iPhone.